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Ruling

Subject: Lump sum payment from foreign retirement account

Issue 1

Question

Is any part of the lump sum payments from a foreign investment scheme established in a foreign country included in assessable income as applicable fund earnings under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Issue 2

Question

Are the adjusted withdrawals made from your client's foreign investment scheme included in your client's assessable income?

Answer

Yes.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Your client held an account in a foreign investment scheme from a foreign country.

The foreign investment scheme is in your client's name and administered by a trust company in the foreign country.

Prior to your client's return to Australia your client was a resident in the foreign country.

Your client has been an Australian resident at all times since your client's return to Australia.

The value of the foreign investment scheme on the date your client became a resident of Australia was advised by you.

During the 2010-11 income year your client withdrew an amount from the foreign investment scheme. Tax was paid on that amount in the foreign country.

Subsequently, during the 2010-11 income year, your client withdrew the remaining amount from the foreign investment scheme. Tax was paid on that amount in the foreign country.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 295-95(2)

Income Tax Assessment Act 1997 Section 305-70

Superannuation Industry (Supervision) Act 1993 Subsection 10(1)

Superannuation Industry (Supervision) Act Section 62

Income Tax Assessment Act 1936 Section 99B

Income Tax Assessment Act 1936 Subsection 99B(1)

Income Tax Assessment Act 1936 Subsection 99B(2)

Income Tax Assessment Act 1936 Paragraph 99B(2)(a)

Income Tax Assessment Act 1936 Paragraph 99B(2)(b)

Income Tax Assessment Act 1936 Paragraph 99B(2)(c)(i)

International Tax Agreements Act 1953 Section 3AAA

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsections 6-5(2) and 6-10(4)

Income Tax Assessment Act 1997 Subsection 6-10(2)

Income Tax Assessment Act 1997 Section 10-5

Reasons for decision

Summary of decision

The lump sum payment from a foreign investment scheme established in a foreign country is not included in assessable income as applicable fund earnings under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997).

The withdrawals that your client will make from his foreign investment scheme, less personal contributions and any amount previously included in their income, are assessable income. Your client may be eligible for a foreign tax credit on foreign income tax actually paid.

Detailed reasoning

Issue 1 Question

Lump sum payments from foreign superannuation funds

From 1 July 2007 the applicable fund earnings in relation to a lump sum payment from a foreign superannuation fund that is received more than six months after a person has become an Australian resident will be assessable under section 305-70 of the ITAA 1997. The remainder of the lump sum payment is not assessable income and is not exempt income.

Before determining whether an amount is assessable under section 305-70 of the ITAA 1997, it is necessary to ascertain whether the payment is being made from a foreign superannuation fund. If the entity making the payment is not a foreign superannuation fund then section 305-70 of the ITAA 1997 will not have any application.

A foreign superannuation fund is defined in subsection 995-1(1) of the ITAA 1997 as follows:

(a) a superannuation fund is a foreign superannuation fund at a time if the fund is not an Australian superannuation fund at that time; and

(b) a superannuation fund is a foreign superannuation fund for an income year if the fund is not an Australian superannuation fund for the income year.

Subsection 295-95(2) of the ITAA 1997 defines Australian superannuation fund as follows:

A superannuation fund is an Australian superannuation fund at a time, and for the income year in which that time occurs, if:

(a) the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and

(b) at that time, the central management and control of the fund is ordinarily in Australia; and

(c) at that time either the fund had no member covered by subsection (3) (an active member) or at least 50% of:

(i) the total market value of the funds assets attributable to superannuation interests held by active members; or

(ii) the sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members;

is attributable to superannuation interests held by active members who are Australian residents.

Thus, a superannuation fund that is established outside of Australia and has its central management and control outside of Australia would qualify as a foreign superannuation fund. The fact that some of its members may be Australian residents would not necessarily alter this.

Initially it must be a superannuation fund and subsection 995-1(1) of the ITAA 1997 definition states:

superannuation fund has the meaning given by section 10 of the Superannuation Industry (Supervision) Act 1993.

Under subsection 10(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act), a 'superannuation fund' means:

(b) a fund that:

(iii) is an indefinitely continuing fund; and

(iv) is a provident, benefit, superannuation or retirement fund; (emphasis added) '

The Macquarie Dictionary (third edition) definition of superannuation fund is:

a retirement fund to which an employee (and usually also the employer) contribute during the period of employment, and which provides benefits after retirement.

In Mahony v. Federal Commissioner of Taxation (1967) 41 ALJR 232; (1967) 14 ATD 519 (Mahony's Case) Justice Kitto considered the expression provident, benefit or superannuation fund established for the benefit of employees. This phrase is slightly different from that above as it excludes the term 'retirement' and includes 'established for the benefit of employees'. However, the judgement in the case still provides a guide as to the meaning of a provident, benefit or superannuation fund.

In the Mahony Case, Justice Kitto recognised that there is no definition in the Act to determine the meaning of a 'provident, benefit, or superannuation fund'. He referred to each of the three terms in the expression separately in his judgment. Justice Kitto said:

the meaning of the several expressions must, therefore, be arrived at in the light of ordinary usage and with only one piece of assistance to be gathered from the immediate context. Since a fund, if its income was to be exempt under the provision, was separately required to be one established for the benefit of employees, each of the three descriptive words "provident" , "benefit" and "superannuation" must be taken to have connoted a purpose narrower than the purpose of conferring benefits in a completely general sense, upon employees…. All that need to be recognised is that just as "provident" and "superannuation" both referred to the provision of a particular kind of benefit - in the one case a provision against contemplated contingencies, and in the other case a provision, to arise on an employee's retirement or death or other cessation of employment, of a subvention for him or his estate or persons towards whom he may have stood in some kind of relation commonly giving rise to a legal or moral responsibility - so "benefit" must have meant a benefit, not in a general sense, but characterised by some specific future purpose.

Justice Kitto went on to state:

First, the trustees were required to pay to or for the benefit of any employee, or to a dependant of his, such sum as the employer might direct; but the direction might be given not only because of some misfortune, but "for any other reason whatsoever", so that the fund was not, because of the provision for these payments, a fund of any of the three special descriptions. Secondly, under provisions in the deed for the winding up of the fund an equal distribution among the employees of the employer was required if, as was the fact at all material times, there was no member. This again, if it should take effect, would yield a benefit to the employees, but not a benefit of any such special character that the fund could properly be described, on that account, as a "provident", "benefit" or "superannuation fund".

Justice Kitto held that the fund had to exclusively be a provident, benefit or superannuation fund and that inferred a purpose narrower than the purpose of conferring benefits in a completely general sense. This narrower purpose meant that the benefits had to be 'characterised by some specific future purpose' such as the example given by Justice Kitto of a funeral benefit.

Justice Taylor also ruled that the fund had to be established exclusively for the purposes set out in the legislation.

A number of cases which have dealt with what constitutes a superannuation fund have referred directly to the decision made in the Mahony case.

The view that a superannuation fund should be established for the sole purpose of providing superannuation benefits on retirement is also supported in the High Court decision Scott v. Federal Commissioner of Taxation (No 2) (1966) 10 AITR 290; (1966) 14 ATD 333; 40 ALJR 265 (Scott). Justice Windeyer said:

There is no essential single attribute of a "superannuation fund established for the benefit of employees"... except that it must be a fund bona fide devoted as its sole purpose to providing for employees who are participants money benefits (or benefits having a monetary value) upon their reaching a prescribed age.

Therefore, these decisions have established that the fundamental characteristic of a superannuation fund consist of a separate and identifiable fund of money or investments set aside and invested to earn income or capital growth for the specific purpose of providing member benefits of money upon retirement, after a prescribed age (see Driclad Pty Ltd v. Federal Commissioner of Taxation (1968) 121 CLR 45; (1968) 42 ALJR 355, Compton v FCT (1966) 116 CLR 233;  (1966) 40 ALJR 366, and AAT Case 10,301 (1995) 95 ATC 374; (1995) 31 ATR 1067.

The Commissioner of Taxation's view is that a fund, to be classified as a superannuation fund, must exclusively provide a narrow range of benefits that are characterised by some specific future purpose, that is, the payment of superannuation benefits upon retirement or death of the individual or as specified under the SIS Act.

Sole Purpose Test

The sole purpose test is contained in section 62 of the SIS Act. The objective of the sole purpose test is to ensure that superannuation funds are used solely for the provision of retirement benefits. As a consequence, we can utilise the conditions established in the sole purpose test as a guide as to what 'benefit' or 'specific future purpose' a superannuation fund should provide.

The sole purpose test is not part of the general definition of a superannuation fund in either the SIS Act or the ITAA 1997. It is however a requirement for funds that want to be regulated under SIS Act. Foreign investment schemes do not qualify to be a regulated superannuation fund as they are established and operated outside Australia.

The early withdrawals feature of the foreign investment scheme, does not fit the conditions established in the sole purpose test. Although foreign investment schemes do not have to meet the sole purpose test, in order for a fund to be considered a superannuation fund, it is important that the fund be maintained primarily for retirement purposes and the sole purpose test provides a guide of what are acceptable purposes.

Due to certain characteristics of the foreign investment scheme, in particular the ability to make early withdrawals for specified purposes with no penalty and withdrawals for non specified purposes at any time with only a small penalty tax, foreign investment schemes generally do not meet the conditions required to be considered to be a foreign superannuation fund as defined in subsection 995-1(1) of the ITAA 1997. These accounts represent a financial instrument in which participants can manipulate to defer current taxes. Therefore, providing for retirement is not the 'sole purpose' of these accounts.

Conclusion

As mentioned above, before determining whether an amount is assessable under section 305-70 of the ITAA 1997, it is necessary to ascertain whether the payment is made from a foreign superannuation fund. If the entity is not a foreign superannuation fund then section 305-70 of the ITAA 1997 will not have any application. In this case as it has been determined that the foreign investment scheme is not a foreign superannuation fund, section 305-70 of the ITAA 1997 will not have any application.

Therefore any payments or distributions from the foreign investment schemes, although paid more than six months after your client became an Australian resident for tax purposes, will not be assessable under section 305-70 of the ITAA 1997.

Issue 2 Question

The assessable income of a resident taxpayer includes ordinary income and statutory income derived directly or indirectly from all sources, in or out of Australia, during the income year (subsections 6-5(2) and 6-10(4) of the Income Tax Assessment Act 1997 [ITAA 1997]).

Ordinary income is defined to mean income according to ordinary concepts (subsection 6-5(1) of the ITAA 1997).

Statutory income is not ordinary income but is included in assessable income by a specific provision in the tax legislation (subsection 6-10(2) of the ITAA 1997). 

Section 10-5 of the ITAA 1997 lists those provisions. Section 99B of the Income Tax Assessment Act 1936 (ITAA 1936) deals with receipt of property from a trust subject to certain exclusions.

Assessability of withdrawal amounts from the foreign investment scheme

Subsection 99B(1) of the ITAA 1936 provides that where, during a year of income, a beneficiary who was a resident at any time during the year receives a distribution from a trust, or has an amount of trust property applied for their benefit, that amount is to be included in the assessable income of the beneficiary. When an amount is distributed to the beneficiary, subsection 99B(1) of the ITAA 1936 applies to include in the beneficiary's assessable income the distribution less any amounts excluded under subsection 99B(2) of the ITAA 1936.

Some of the exclusions set out in subsection 99B(2) of the ITAA 1936 that could apply in your client's case are:

· the corpus of the trust (paragraph 99B(2)(a) of the ITAA 1936)

· amounts that would not have been included in the assessable income of a resident taxpayer who was presently entitled to the amounts at the time they were derived by the trust (paragraph 99B(2)(b) of the ITAA 1936), and

· amounts previously included in the beneficiaries income under section 97 of the ITAA1936 (paragraph 99B(2)(c)(i) of the ITAA1936).

In your client's case, the withdrawals that they will make from their foreign investment scheme, less their contributions and any amount previously included in your client's income are assessable to your client under subsection 99B(1) of the ITAA 1936.

Foreign income tax offset:

Whether your client is eligible for a foreign tax credit is dependent on the relevant double tax agreement between Australia and the foreign country.

Australia has a tax treaty with the foreign country (foreign country Convention).

The foreign country Convention operates to avoid the double taxation of income received by Australian and foreign country residents.

Under an Article of the foreign country Convention your client's share of distributions from the foreign country are taxed in the country of source and may be taxed in Australia. However, another Article of the foreign country Convention provides for relief from double taxation. Accordingly, your client will be entitled to a foreign income tax offset in respect of the foreign tax paid in the foreign country.

To be entitled to a foreign income tax offset:

· your client must have actually paid, or be deemed to have paid, an amount of foreign income tax

· the income or gain on which your client paid foreign income tax must be included in your client's assessable income for Australian income tax purposes.

Calculating the offset

Your client can claim the foreign income tax offset in your client's income tax return. If claiming an offset of $1,000 or less, your client only need to record the actual amount of foreign income tax paid on your client's assessable income (up to $1,000).

If claiming a foreign income tax offset of more than $1,000, your client will first need to work out your client's foreign income tax offset limit.

For further information see The Tax Office publication Guide to foreign income tax offset rules 2010-11, which is available on the Tax Office website at www.ato.gov.au